Thursday, November 6, 2008

Asian Investors 'Accumulate' Big Losses on Risky Contracts - WSJ

By LAURA SANTINI
HONG KONG -- Amid widespread losses investors have suffered in the global financial crisis, one financial product popular in Asia has surfaced as the culprit behind a painful destruction of wealth for individuals and businesses alike.
Called an "accumulator," it is essentially a contract that obliges investors to purchase a security, currency or commodity at a fixed price -- often set at a discount to prevailing market rates -- at regular intervals. When the market price is above the fixed purchase price, the investor makes money. When it falls below the fixed price, the investor loses, sometimes quite a lot. Contract terms typically last a year.
In Hong Kong, recent losses from stock accumulators have led to dozens of complaints to regulators and legislators from disgruntled investors. Chan Kam-lam, a Hong Kong legislator, says he has heard from 50 or so individual investors, many of whom say they didn't fully understand the risk or blame their private bankers for pushing them into the products. Some individuals he has talked to have lost as much as $25 million.
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Many don't want to speak out publicly, Mr. Chan says, because they are prominent figures, such as company executives.
"They are afraid that this kind of publicity may have a bad influence on their business," he says.
Accumulators are among a number of structured financial products and derivatives that were sold to investors during headier times, when their downside risk seemed remote, but which are now wreaking havoc on private portfolios and corporate balance sheets amid huge volatility in global financial markets.
A fairly new flavor of derivative, the accumulator has led to big losses in some unexpected places. Among them: the books of VeraSun Energy Corp., one of the top three ethanol producers in the U.S., which filed for bankruptcy protection Friday. VeraSun had entered into accumulator contracts linked to the price of corn -- ethanol's key ingredient -- that led to big losses when those prices plunged amid a broader downturn in the commodity markets.
Citic Pacific Ltd., a Chinese-backed conglomerate listed in Hong Kong, recently reported a possible loss of nearly $2 billion, or more, thanks to its investments in a currency accumulator linked to the Australian dollar, which has fallen sharply against the U.S. dollar in recent months. News of the expected loss has punished the stock and has forced the company's Chinese parent to offer a rescue loan package.
Among the hardest-hit victims have been wealthy individual, or "retail," investors who bought stock accumulators in Hong Kong, by far the biggest market for the product, according to bankers. Hong Kong's financial regulator, the Securities and Futures Commission, estimated earlier this year that about $23 billion in accumulators remained outstanding.
What made them so popular? For one, years of rising equity prices and a dearth of fixed-income alternatives in Asia stoked interest in a number of equity-linked derivatives, including accumulators. Many people also appeared attracted by what seemed at first glance to be a great deal: the ability to buy stocks at a discount to the prevailing market price. This enhanced the impression that a bank's private-wealth clients were getting an exclusive offer only available to a select group.
And during the bull run in stock prices, when accumulators were most popular, many investors consistently underestimated the risk of a major, long-lasting downturn in shares that could leave them dangerously exposed.
As investors once enticed by the "discount" on their shares saw their losses mounting, they developed a new nickname for the accumulator: "I kill you later."
"Accumulators are ruining Hong Kong," says Andy Xie, an independent economist who previously worked at Morgan Stanley. Mr. Xie says that several acquaintances have lost large sums of money on the products.
"The fundamental flaw with nearly all structured products that were developed is something that I learned from my grandmother: You get nothing for free," says Kathryn Matthews, chief investment officer for Asia at Fidelity Investment Management Ltd., which doesn't operate a private bank or offer accumulators.
Some investors have settled quietly for undisclosed sums with their private banks, according to people familiar with those negotiations. Others have opted to cut losses and terminate the accumulators, by selling them back to private banks for far less than their original purchase prices. Still others are hanging on to those investments, hoping a market rebound will restore ailing account balances.
One victim is Joyce Tsang, founder of a cosmetics and beauty-products retailer in Hong Kong, who alleges in a lawsuit filed here that her private banker, Goldman Sachs, engaged in unauthorized trading of accumulators for her account. Later this month, Ms. Tsang will seek damages from Goldman for losses she incurred when those accumulators went bad, according to a court filing.
Neither Ms. Tsang nor her lawyer responded to messages concerning her lawsuit against Goldman. A spokeswoman at her company, Modern Beauty Salon Holdings Ltd., declined to comment. A Goldman spokesman said the bank was confident the legal process "will show these claims are without merit." Private bankers elsewhere also declined to comment on the products, citing the sensitive nature of the controversy.
The accumulator got its start in Europe as a corporate product, designed primarily for companies looking to build stakes in one another without causing sudden spikes in the share price of the target company.
Later, when private bankers began marketing the product to retail investors, the Asian market proved a lucrative source of new business.
Here is how an accumulator might have worked for an investor interested in accumulating a large position in China Mobile, one of the country's biggest telecom stocks.
A year ago, China Mobile was trading around 142 Hong Kong dollars (US$18.32) a share. An accumulator might have offered investors the ability to buy 1,000 China Mobile shares every month for a price of HK$114, or 20% below market price. The contracts typically included a "knock-out" clause, which terminated the contract once the stock appreciated 5%, or in China Mobile's case reached HK$149. If the stock reached that level, the return on the investor's outlay was 31%.
But here's the rub: Investors were contractually obliged to keep purchasing the shares at HK$114 regardless of whether they rose or fell. There was another nasty twist: Many accumulators required investors to double down on purchases if shares dropped, buying 2,000 shares instead of 1,000 at a price that now put them in the red.
For the 12-month accumulator, set in November 2007, investors quickly found themselves in this situation, as China Mobile's stock bounced around in the market's volatility. On Wednesday, the company's shares closed at HK$71.60 -- down 37% from the HK$114 purchase price. And because the investor is locked into making more purchases over the life of the contract, he keeps adding to his losses with each purchase.